Bank of England Monetary Policy Committee

Today, the Bank of England Base Rate has fallen today to an all-time low of 0.25% and you might be wondering “what difference will that make to me? A 0.25% interest rate cut is probably not going to save me much money on my monthly bills, all it will do is make it harder for me to make money on my savings, so why bother?”

The good news is that in theory, lower interest rates can boost the prices of assets such as shares and houses. Higher house prices enable existing home owners to extend their mortgages in order to finance higher consumption. Higher share prices raise households’ wealth and can increase their willingness to spend. (source: Bank of England)

However, when making these sorts of decisions the bank of England don’t just think about things at this level. It’s not just about how it will effect mortgage rates for example or savings rate.

Take a step back a bit and think about the implications of Brexit. Economic growth is slowing, unemployment is expected to rise and there’s a lot of uncertainty about how a post-Brexit UK will operate on the world stage. One of things we need to do is make the UK a competitive place to do business. Now, let’s say you own a foreign international company looking for a place to set up a new business in this part of the world or you are already in the UK and wondering whether to spend money to invest / expand your company. Now we’re potentially not in the EU single market in a few years so why take the risk of investing in the UK now?

Well, a lot of companies do not fund investment using money they already have. They borrow. So making it easier for companies, especially the larger companies in this example, to borrow money at a lower cost means it’s more attractive to run and expand a business in the UK. For example if I want to borrow £100million the interest on that money today with the base rate @ 0.25% could be a lot less than it was yesterday at 0.5%. So this might be an incentive for firms to stick with the UK and invest more money here. Add to this the fall in the value of Sterling against other currencies, making exports cheaper and some of the risks of post-Brexit investment in the UK start to disappear.

The same could be said for smaller businesses who may find it harder to survive in a post-Brexit world. This may be only a slight decrease in cost but it is to try and provide the confidence that as a country we are open for business and to get firms to carry on investing by making funds available whilst reducing the cost of repaying their debt.

Also worth considering is the impact on the banks. The UK based banks have recently had their capital requirements (the money they have to keep in safe assets such as cash) reduced in light of the Brexit result. Since the banking crisis in 2008 the amount of capital the banks had to hold in accessible, liquid safe assets was dramatically increased to try and stave off future problems. This was to ensure that if there was another banking collapse, the banks would have enough money available to keep going and survive a ‘run’ like we saw with northern rock for example.

Effectively, what the banks have also been doing is hoarding money, keeping it in cash to try and reduce the risk to their business and their shareholders. The money held in reserve with the bank of England up until today, would have been earning the base rate, 0.5% pa– certainly not an attractive rate. Today, the money that they leave with the bank of England gives a return of 0.25%. This may seem like an insignificant reduction but when you consider the £millions / £billions banks have at their disposal, that could represent a significant loss of income for any UK based bank.

The BoE has also launched a new scheme aiming to provide as much as £100bn of new funding to banks to help them pass on the base rate cut to the real economy. The “term funding scheme” (TFS) will see the BoE create new money to provide loans to banks at interest rates close to the base rate of 0.25% and will charge a penalty rate if banks do not lend.

They have also unveiled plans to inject a further £60bn in electronic cash into the economy to buy government bonds, extending the existing quantitative easing programme to £435bn in total. A further £10bn in electronic cash will be created to purchase corporate bonds from firms “making a material contribution to the UK economy” (source: ibtimes)

The hope is that the banks will no longer want to leave money sat at the Bank of England. With the increased levels of ‘liquidity’ they will start deploying more money into the economy – they will lend it, they will help smaller businesses with lower cost loans, they will try to get a return on their capital in a different way rather than leaving it with the central bank at such a low rate.

Now the thinking behind this is what we call ‘macro’ economics. If making it easier and cheaper for companies to borrow to invest and expand, the hope is that there will be more jobs created and more growth in the economy. It could also help reduce the cost of the goods and service made in the UK making us more competitive. How much a 0.25% cut in interest rates will impact on this, only time will tell. It does seem to be a relatively small amount but I guess the policy makers are running out of options.

On a personal level, it means that having money in cash based savings is likely to be even less attractive going forwards that it has been over the last 7 or 8 years – which is saying something considering where we’ve been. I for one fully appreciate that as goods and services get more expensive, I get poorer, even though I’ve still got the same £s and pence in the bank.

So, I always make sure that I have money in different pots. A pot of money that I might want to spend in the near future, another pot for emergencies for unexpected expenditure and another pot that I need to grow – as it is going to be sat there longer and will be used to replace the other two pots when I spend what’s there.

That’s where investment advice and financial planning is so important. It can help you establish what you should put into your pots, and how to invest and save that money to try and reduce the impact of low interest rates and the other risks involved – whether that is from the markets, interest rates, inflation, currency, etc.

For anyone out there who is wondering what impact this might have on their capital and thinking it may be about time to start doing something more positive with their wealth, now is the time to get in contact with a financial adviser. The advisory team here at Grosvenor are completely independent and will be happy to help you navigate your way through these challenging times and build a financial plan that’s right for you.

Author: Adam Holmes, Grosvenor Consultancy Ltd

There are advantages and disadvantages to using all of these strategies and they depend on individual circumstances so don’t take action without seeking competent advice. Tax rules, rates and allowances are all subject to change. The Financial Conduct Authority does not regulate tax advice and some forms of offshore investments. The value of investments and the income from them can fall as well as rise and you may not get back the full amount you invested.

The information contained within this document is correct as at 2015/16 tax year and are based on current government legislation. These can change.

About Grosvenor

Our aim is to provide a service that successfully translates complicated issues into manageable ones; to help our clients understand the importance of ‘context’ in making financial arrangements and most of all to ensure that our clients feel comfortable and confident in their dealings with our business.

Grosvenor Consultancy Ltd is Authorised and Regulated by The Financial Conduct Authority and is entered on the Financial Services Register under reference number 187799. Registered in England and Wales No. 3509936.